Mind the Gap

Cash flow from operations isn't keeping pace with net income at many companies, and investors are beginning to notice. Our exclusive study of the Standard and Poor's 500 reveals which companies have the widest gaps between the two measures.

Accordingly, we asked the data-retrieval firm Standard & Poor’s Compustat to compare the growth in cash flow from operations for the companies in the S&P 500 Composite Index with the growth of their net income for the past three years. We list the 100 companies with the greatest growth gaps. More than 50 companies experienced growth in net income that exceeded that of their operating cash flow by at least 100 percent. And of those companies with at least $100 million in quarterly net income as of the end of the three-year period, earnings growth in 29 cases exceeded operating cash flow growth by at least 25 percent.

Noteworthy Chasms

Consider, for example, Eastman Kodak’s yawning gap of 45 percent, which placed it at #90 in the S&P’s Compustat study. Analysts say this reflects the company’s inability to match cost cuts with top-line growth in any of its most promising business segments. In much-vaunted digital cameras, for instance, the company is losing market share to such competitors as Canon Inc. and Sony Corp., according to Benjamin Reitzes, an analyst for PaineWebber Inc. At the same time, says Reitzes, what sales Kodak is generating there could threaten sales of its basic film business.

While Eastman Kodak declined to comment, its lagging cash flow growth is far from the worst among the S&P 500, according to the S&P’s Compustat study. That dubious distinction goes to Ryder System Inc., a Miami-based logistics and transportation firm, whose operating cash flow growth trailed that of its net income during the period in question by an astronomical 67,000 percent. The problem is a legacy of Ryder’s history as a diversified transportation services firm.

“We were almost a holding company” as recently as 1996, notes Ryder CFO C. J. “Corky” Nelson. And while the company exited most of its poorly performing businesses, including consumer truck rentals and school bus services, that cost the company almost 60 percent of its revenues. Meanwhile, the company has had to spend heavily to exploit opportunities in its fastest-growing business segment–corporate supply-chain logistics–and that has held back the stock’s performance. Similarly costly business-model transitions explain lagging cash flow from operations at such companies as PepsiCo Inc. (#61) and Texas Instruments (#6). And high-tech start-ups such as Xilinx Inc. (#14) find their way onto the list because they’ve upped their spending to boost growth (see “Capital Exceptions,” below).

But that’s not the case at some other companies high on the S&P’s Compustat list. Growth in cash from operations at Motorola (#44), for instance, trailed that of net income during the period analyzed by a margin of 128 percent. The company declined to comment, but some analysts contend that for one thing, the bankruptcy of the Iridium satellite communications consortium, in which Motorola invested heavily, has had a significant impact on performance. Indeed, while the company disclosed a $740 million hit to its fourth-quarter earnings last year, these analysts believe the Iridium investment remains a drag on cash flow. During the first quarter of 2000, normally a solid quarter, Motorola posted a $900 million cash flow deficit, its largest in the past nine quarters, according to an analyst who spoke on condition of anonymity. And the company has at least another $374 million to pay on Iridium-related reserves, says the analyst.


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